Has Forbes Ever Met a Planned Gift It Liked?

Summary

The September 20, 1999 issue of Forbes magazine has published a series of articles under the banner of "Caveat Donor: The stockbrokers, planners and insurance salesmen who used to peddle tax shelters have a new grift: charity. Some of their donation schemes work, some are shaky and some are downright dangerous to your finances." In this article, we take exception to some of Forbes' charges.

Forbes has placed the articles online, so before proceeding further, you might want to follow the links above and take a few minutes to read them.

The new giving game begins with a transaction between a donor and the National Community Foundation (NCF), a subsidiary of the New Life Corporation of America, an IRC §501(c)(3) organization that markets donor-advised funds and charitable gift annuities through advisors.

NCF and several similar organizations are on the 10 Most Wanted lists of national charitable associations such as the National Committee on Planned Giving and the American Council on Gift Annuities. Why? Because NCF's practice of paying commissions to planners (of up to 6% of amounts transferred by clients in exchange for gift annuities) flies in the face of the Model Standards of Practice for the Charitable Gift Planner and, in the opinion of NCPG and ACGA, violates provisions of the Philanthropy Protection Act of 1995. The Act relieves charitable organizations from securities registration requirements provided the solicitor is an employee of the issuing organization or a volunteer, and no commission or other special compensation is paid in connection with the transfer.

Concerned that such practices will spawn "corrective" legislation to apply securities and state insurance regulation to all gift annuities, both NCPG and ACGA issued identical resolutions denouncing the commission-paying practice.

In the transaction referenced in the article, a donor transferred real property to NCF in exchange for a charitable gift annuity and planned on claiming a deduction for the full net proceeds after it was sold by NCF. Those familiar with gift annuities know the deduction is limited to the net value of the property on the date of transfer less the present value of the annuity. NCF President Michael Sheppard stated that NCF understands these rules and provides deduction calculations to all donors with whom it enters into gift annuity contracts. The organization also issues annually Form 1099-R to annuitants, which describes the tax character of annuity payments, said Sheppard. With respect to the payment of commissions violating industry ethical standards, Sheppard justified the practice by stating that NCF's cost of fundraising fell well below that of other organizations.

Granted, NCF with its controversial commission practices and prior promotion of now prohibited charitable split-dollar plans may be a worthy target for criticism; it is where the article goes from here that gives us concern.

Keep in mind, the majority of Forbes' audience is the lay-public. Particularly disconcerting is that although Ms. Novack cites some clear-cut abuses such as the so-called "chutspah" CRT, charitable split-dollar, and the possible marketing of the "Sickroom" CLT, she also seamlessly blends them with traditional and prudent forms of planned gifts. The line between the two becomes nearly indistinguishable to the lay-reader. One is reminded of the phrase, "burning down the barn to get rid of a few rats." And Forbes has thrown a lit match.

"The charity hustlers are urging investors to buy into complex strategies that involve irrevocable commitments that play out over a long time. Their pitch is that you can use the tax code's breaks for charity both to do good for others and to do well for yourself."

Since when is using the "tax code's breaks" for the benefit of charity and the donor a crime? Is Ms. Novack referring to "loopholes" that fall outside of the spirit of the law? To us, it sounds like an indictment of the fundamental tax policy upon which planned giving is based. Does Forbes oppose the charitable deduction itself (perhaps in favor of a flat tax)? Does this make anyone who promotes planned giving a "hustler?"

Are All Planned Gifts "Schemes?"

"If you are prosperous, you are going to get pitched, sooner or later. Here's a rundown of several current schemes."

"Insurance salesmen love CRUTs. They can market them with a life insurance trust that "replaces" for heirs the asset that the donor has given away. What these salesmen don't say is that there are other ways to soften or forestall a capital gains hit: installment sales, exchange funds, Section 1031 exchanges or just leaving the asset in your estate."

Is a textbook charitable remainder trust combined with life insurance for family asset replacement in and of itself a scheme? No, we don't think so. (Webster uses words like "shrewdly devious" to define a scheme.) But is it a scheme when planners, lured by personal economic gain, misrepresent the tax economics of the transaction, or knowingly fail to present planning alternatives? Forbes' criticism is harsh, and not entirely misplaced.

"Insurance salesmen often embellish further, comparing results for a CRUT-life insurance trust combo with doing not even the simplest estate planning, such as making $10,000 annual tax-free gifts to children or setting up the same insurance trust to pay estate taxes."

While these charges are difficult to hear, there is a lesson: Charitable gifts should not be sold purely as tax and financial planning vehicles, they should be presented as philanthropic planning vehicles that provide tax and financial planning benefits.

The "Chutzpah" CRT. The "Chutzpah" trust was discussed by the PGDC in an earlier Planned Giving Online article entitled, Here We Go Again: The Son of Accelerated CRT). Frankly, we are surprised the technique has not yet produced a prompt notice of condemnation from the IRS as did its predecessor.

Spigot Trusts. With respect to "spigot" trusts (i.e., a net income unitrust invested to enable income deferral), Ms. Novack states in part, "And the IRS seems to be tolerating donor-friendly manipulations of charitable trusts it once would have frowned on, such as investing in variable annuities to game the timing of income... So annuity sellers began aggressively pushing a solution last year based on a narrow ruling they took as a green light?" Gaming? Last year? We beg to differ.

Ltr. Rul. 9009047 was issued in late 1989 with insurance companies promoting the use of deferred annuities as trust investments ever since. Has the IRS and Treasury scrutinized the concept? Yes, in its internal CPE text for 1997 an article by Exempt Organizations chief Marcus Owens appeared suggesting income deferral might constitute a prohibited act of self-dealing. In April of the same year, Treasury issued proposed regulations that solicited comments on "net income unitrusts holding certain investments." The following November, public hearings were held at which comments from the private and not-for-private sectors overwhelmingly favored permitting income deferral in charitable remainder trusts. And in January of 1998, the Service issued TAM 9825001 in which, among other issues, it concluded that in the specific case at hand income deferral did not constitute an act of self-dealing.

"Through all this, of course, no one mentions that such strategies may well violate the trustee's legal duties to the charity as a fiduciary. There is also a real risk that the IRS will decide that donor-dominated management disqualifies the trust."

Again, we take exception with this comment and one earlier in the article regarding donors serving as trustee "carrying legal risks" as being misleading and alarmist.

First, Rev. Rul. 77-285 permits the grantor to reserve the right to remove the trustee for any reason and substitute any other person (including the grantor) as trustee.

With respect to fiduciary duties, the trustee is required to balance the competing interests between income recipients and charitable remainderman and to consider the needs of each. From an investment standpoint, the trustee must balance each party's need for investment performance, income, and the preservation of capital. With respect to net income CRTs holding commercial annuities, a special independent trustee should be given sole authority regarding income withdrawals under the contract.

Would the holding of a commercial annuity contract by a CRT violate the adequate diversification requirements of the Uniform Prudent Investor Act? This concern may have merit if the sole investment is one fixed annuity contract. However, the use of variable annuity contracts, which contain multiple subaccount investment options (akin to mutual funds) should protect the trustee. Ms. Novack fails to mention one important element of many variable annuity contracts--a death benefit that ensures the charitable beneficiary receives at least the original investment amount regardless of investment performance.

Finally, suppose the IRS reverses course and prohibits donor-trustee arrangements or the practice of income deferral. The article implies the trust would be disqualified. It seems unimaginable that after so many years, the IRS would reverse its position when practical alternatives, such as the selection of an independent trustee or simply turning some or all of the income on, would lessen the blow to charity and non-charity alike. Nevertheless, the technical justification for disqualifying an income deferral or donor-trustee charitable remainder trust is lacking.

Single-Member LLCs. Continuing on the theme of the spigot trust, Ms. Novack then attacks the use of single member LLCs as a superior investment alternative to variable annuities (because such devices enable the passthrough of capital gains, unavailable to deferred annuities):

"To show how crazy things have gotten, there's an even more complicated variation on this scheme."

There's that word again. Why have spigot unitrusts been allowed to exist for nearly ten years and why have for-profit and not-for-profit planners endorsed their use? If one defers income, such amounts may ultimately find their way into the hands of charity.

Is IRS and Congressional response (or lack thereof) to the spigot trust distinguishable from the other techniques such as charitable split-dollar, and the accelerated CRT and its progeny? Clearly. Has the Service and Congress had ample time to examine the issue and make arguments condemning the technique or legislate it out of existence? Yes. Did it do so? No. However, the Service, pursuant to Rev. Proc. 97-23 continues to study the issue.

Are there clear remedies that would not jeopardize the qualification of the trust in the event the Service reverses its position? Yes. Should planners still proceed with caution and advise clients that although income deferral has not been prohibited, neither has it been officially sanctioned? Yes. We must never lose sight of the fact that the favorable TAM regarding commercial annuities in CRTs applies only to the taxpayer whose audit was addressed.

However, Forbes may not have considered another "angle." Might donors be establishing income deferral unitrusts to give potentially more to charity, but have income available for a rainy day? That, however, would presuppose donors have donative intent.

Donor-Advised Funds.Forbes even vilifies donor-advised funds, a powerful vehicle used not only by a few national charitable foundations established by commercial entities, but also by mainstream community foundations and other charities to assist donors by identifying community needs and funding them. As a hypothetical example, the author suggests that Stanford (University we assume) will receive a gift only if it matriculates the child of a donor who does not meet its rigid admission standards. Again, this type of rhetoric casts a cynical light on a vehicle that has so many other beneficial uses--none of which are mentioned in the article.

Charitable Lead Trusts. With respect to charitable lead trusts, the article describes one technique that should be approached with care, the family limited partnership "enhanced" CLT (see The Family Limited Partnership by Michael Bourland, Esq.), and another that should be avoided altogether, the "Sickroom" CLT. In the latter, a donor established a nonreversionary nongrantor CLT naming children or grandchildren as remaindermen. Such trusts are typically established for a fixed term of years so the present value of the income interest (the charitable deduction) can be determined with certainty. In this case, however, the trustor is not healthy (but does, according to doctors have a life expectancy of at least two years), so instead of a fixed measuring term, the trust is measured by the trustor's life. The result is a trust that may produce a large deduction, yet terminate well ahead of the trustor's actuarial life expectancy. But what if the donor is healthy? Can you still play the tables? Sure, just find someone who isn't feeling well and link the payments to their life.

"San Francisco planner J.J. McNab reports being approached in July by a lawyer offering $5,000 a head for unwell young folks willing to lend life expectancies to healthy donors. In this way, the remainder for heirs can be calculated using the average (long) life span of a young person. When this unfortunate stranger dies young, heirs get a bundle."

If there is an example of "gaming" the rules, this is certainly it and we share in Ms. McNab's nausea that planners would seek such arrangements. But does Ms. Novack mention the many noncontroversial and beneficial uses of the charitable lead trust? Again, as with the CRT, readers who have never heard of a CLT are left with an image of a vehicle rife with abuse. Where is the balance?

Outright Gifts to the Rescue?

"? investors will be so mesmerized by a potential tax shelter that they ignore simpler, cheaper ways to accomplish both their charitable and financial goals. Example: Simply by giving highly appreciated stock directly to charity while you are alive, you can cut the costs to 40 cents on the dollar or less. Leave an IRA to charity at your death, and the gift can cost as little as 25 cents on the dollar--without a complicated trust."

According to Richard C. Sansing, Associate Professor of Business Administration at the Tuck School of Business at Dartmouth, Ms. Novack's assertion that outright gifts can fill the bill is disingenuous. In postings found on the GIFTPLAN and Gift-PL listservs, Sansing stated, "The goal of an investment vehicle like a charitable remainder trust is for the investor to (1) continue to receive the benefits of the donated property while they are alive while (2) getting an income tax deduction now for making the irrevocable commitment to donate the asset to charity when they die. Direct donations of property do not achieve the first objective; donations at death do not achieve the second. It is dishonest to criticize the outcome of a set of tax policies without opposing the fundamental elements that create them. Does Novack oppose a deduction for the value of appreciated property donations? Does Novack oppose a deduction for the donation of a future interest in property? If so, say so, and clearly."

Sansing continues, "But there is an uglier side to Novack's discomfort with these investment strategies. Consider this statement:

"The donors listen eagerly. They especially love the many new ways to give money away and still control it...Such control was once available only to the wealthiest, who could afford private foundations; now you can do it with $10,000 at Fidelity."

"Yes, the world has changed," says Sansing. "More people have access to stock ownership via lower transactions costs. More people are in a position to use complicated financial arrangements like trusts and foundations to achieve their charitable and personal financial goals. The suggestion that such techniques should only be available to the wealthiest reflects an ugly class bias that is not a legitimate basis for public policy."

We couldn't agree more. It is clear the change agent lowering the barriers to entry to sophisticated philanthropy is technology. The ability to quickly and accurately project the tax and cash flow benefits of various planned giving strategies and compare them to noncharitable alternatives has clearly lead to the creation of more gifts. The standardization and automation of document assembly, trust administration, investment management, and tax compliance has created efficiencies that make planned gifts at smaller amounts possible. If Forbes chooses to characterize these efficiencies as "TV dinners," we say get the oven warm.

Is There Hope?

In A charitable hedge, Ms. Novack chronicles the gifts of married entrepreneurs whose wealth consisted largely of stock and partnerships from a successful cellular business. They made outright gifts to a donor-advised fund of $600,000 and gifts to a charitable remainder trust of another $2,000,000, which produced an additional $200,000 deduction. The combined $800,000 deduction would offset taxable capital gains from the sale of other assets.

If all goes well in their financial future, the donors intend to contribute a portion of their income interest in the CRT to their donor-advised fund, in essence accelerating a portion of the remainder interest. Are the donors "hedging" their gift (read: reducing personal financial risk)? Absolutely, in their early forties, they have established a trust that can diversify their investments and provide for their income needs until they decide they can financially give more. With respect to the characterization of the technique as involving "hedging" and "arbitrage," the couple's planner, David Harris, told Forbes that less sensational words could be used to describe the gifts as well.

The "little-known technique § allowed by the IRS in a 1995 private letter ruling" that will enable the couple to give pieces of their right to receive income from their trust has its basis in Rev. Rul. 86-60, which allows income and gift tax deductions for a gift of an income recipient's entire annuity or unitrust interest. The question of whether income recipients can give fractional income interests is addressed in Ltr. Ruls. 8805024, 9529039, 9550026, and 9817010.

If there is a faint glimmer of hope, it might be found in Finding the inner philanthropist where Ms. Novack chronicles the plan developed with the guidance of Family Wealth Counselors founder Kenneth Fink. We say "faint" because the sole reported motivation for including charity in the plan is tax avoidance. Although tax planning is a key component of the estate planning process, and charitable planning is the most effective way to eliminate substantial tax, "tax considerations" are not at the top or even close to the top of the list of why most people give. In what is perhaps the seminal work on the subject, Mega Gifts, Jerold Panas ranks "tax considerations" twentieth on a list of 22 reasons people give to charity. First was "belief in the mission of the institution." Last were "guilt feelings." It's a shame some of the donors' altruistic motivations didn't surface in the article as well.

Summary

So what can be learned? Is there abuse in planned giving? Yes. Does everyone agree on a definition? No. Are there advisors who need to look past the gleam of tax benefits and personal remuneration to the reason people give? Yes. Is there a message amongst all the vitriol? Yes, and perhaps it is this:

Financial, commission, tax driven deals will always be a magnet for criticism and worse, may lead to changes in tax policy. Conversely, if one first uncovers in the mind of the prospective donor the heart to make the world a better place, and then goes about suggesting ways of accomplishing it that are within the spirit and intent of the rules, one will be above reproach.

Rumor has it another article is in the works at Forbes that illustrates the good in giving. Has Forbes ever met a planned gift it liked? Perhaps we'll find out in a future issue.